You can hear a global sigh of relief as crude oil prices begin to stabilize after a 75 percent decline over the last year, from a high of over $140 a barrel to $30. There is a false sense that the recent lows in the price of crude oil are artificial, and that higher prices will return. But that assumption is wrong. Contrary to popular belief, the current low price of oil is not the exception the media and political leaders keep telling us, it is the historical norm.
While projecting oil prices is always uncertain given geopolitical instability and OPEC's capacity to intervene in the market, governments, businesses and individuals should at the very least begin planning for a future in which the price of oil reverts to its historical norm of $20 to $40 a barrel.
For 60 years, from 1946 to 2006, the average price of a barrel of oil adjusted for inflation was $40 -- and that includes both the Middle East price shock of 1973 and the price spike after the Iranian revolution in 1979. Excluding those shocks, the price has been lower, fluctuating between $20 and $40. Even in the recent past, from 1986 to 2006, the average price of a barrel of oil sat exactly where it is today, around $30 a barrel.
What should have come as a surprise were the extraordinary prices oil traded for between 2006 and 2015, at over $100 a barrel. To give a sense of how high those prices were the last decade was the only time in modern history when the price of a barrel of crude oil exceeded $40 without a clear supply disruption (1979) or fundamental market shift (1973). In fact, the only other time the price of a barrel of crude oil has ever exceeded $100 for a sustained period -- the norm over the last decade -- was for a single year after the 1979 Iranian revolution.
Foreign policy, federal economic initiatives, corporate budgets and individual planning need to incorporate the reality that what is happening in the oil markets right now is not anomalous; it is in fact a restoration of the norm. What are your plans for a world in which the price of oil fluctuates in a band around $30 per barrel?
First, A Little History
In the summer of 2008, oil production in the United States fell to about 5 million barrels a day. The New York Times and other media were writing seemingly credible articles about "peak oil": the moment when the world oil production would reach its maximum point and begin an inexorable decline. The implications, we were told, would be vast: accelerated demand for renewable energy and electric cars; ever-greater strategic importance of the Middle East; higher gasoline and home heating oil prices.
Then the shale oil revolution happened.
The discussion about peak oil ignored the inevitability of technological innovation, including the emergence of fracking. It ignored the fact that already by 2008, innovations in drilling were allowing oil exploration in the shale formations of Northern Plains, West Texas and upper Appalachia. Over the next seven years oil production in the United States nearly doubled, from 5 million barrels a day to over 9 million barrels. To put that vast growth in US production into perspective, global demand for oil rose from about 88 million barrels per day in 2008 to 93 million barrels per day in 2015. The increase in U.S. production alone absorbed the entire growth in global demand
But the boom in oil production in the United States is only one factor in the global marketplace that is driving down oil prices back to their normal range.
Old Oil
For the first time in decades, there are large reserves of low cost "old oil" coming back on the market from traditional suppliers using traditional technology.
Iran: Crude oil production in Iran was as high as 5 million barrels a day before now decades-old international economic sanctions drove production down to today's 3.3 million barrels. The end of sanctions could restore Iran's production to traditional levels, adding over 1.5 million barrels a day to global supply. Iraq, not a paragon of stability, produces 1 million barrels a day more than Iran does with about the same level of reserves. The easing of sanctions has already yielded Iranian production deals with European companies.
Venezuela: Despite proven reserves that exceed Saudi Arabia's, Venezuela produces 75% less oil than the Saudis, fewer than 2.5 millions barrels per day. Restoring production to just its prior peak of 3.5 million barrels a day would add another 1 million barrels to the market. Recent elections, which yielded a reform-minded legislature, could presage the kind of economic opening that will restore that production.
Iraq: Oil production has already risen from 2.5 million barrels a day in 2012 to 4.3 million today and continues to rise. The development of what is already a semi-autonomous Kurdish state with substantial reserves of its own will only add to production.
Libya: The persistent violence and chaos in Libya that followed Arab Spring has brought production down from over 1.5 million barrels a day to below 500,000. At its peak, Libyan production was as high as 2 million barrels a day. When order is restored, production levels will rise.
Latent capacity in just those four countries could add 4.5 million barrels a day to global oil production, bringing as much supply to the market over the next decade as fracking in the United States did in the last.
New Oil
Technology has radically altered the development of new oil reserves, and any price increases will make those new sources economically viable, effectively creating a series of hurdles to higher prices.
U.S. shale deposits: The technological revolution in shale drilling continues unabated. Companies are finding ways to produce oil at a marginal profit from already drilled wells at prices as low as $30 a barrel. New wells are beginning to be drilled with break even at prices as low as $35 a barrel, as companies learn to explore and produce ever more efficiently. The latent exploration capacity in the shale lands effectively creates a price ceiling at $30 to $40 a barrel, roughly the point at which exploration in shale formations resumes, and production growth returns.
Importantly, shale formations are not unique to the United States. China, Argentina, and Eastern Europe all have similar formations and are in early stages of exploration.
Canadian tar sands: Sitting just north of the United States are the vast, hard-to-extract and polluting Canadian tar sands that represent as large a pool of oil reserves as Nigeria, Libya and Russia combined, the third largest reserves in the world. While the US expanded production by more than 4 million barrels a day since 2008, Canada expanded production by over 1 million barrels a day, despite opposition to the pipelines and other infrastructure needed to help it bring production to world markets.
The tar sands create a second price ceiling. Improved extraction methods have now moved the cost of new production to below $50 a barrel, and the development of secondary pipelines and rail-based transport has created new ways to get that oil to market.
New offshore production: It is hard to remember now, but in the days of the peak oil dialogue in 2008, there were a series of large oil finds that were expected to bring millions of barrels of oil per day online over the ensuing decade. Off the northeastern coast of Brazil, the Gulf Coast of Mexico, even in the eastern Mediterranean off of Israel were vast oil and gas finds which were expected to be the next wave of new oil before fracking transformed the shale opportunity.
Every offshore field is unique, but prices above $70 a barrel make most deep-water projects viable, a third price hurdle to any notion of a return to $100 oil.
Off Limits Oil
Last, we need to remember that environmental and other considerations have taken substantial pools of potential reserves, some likely low cost, off the market--for now.
All over the world sit economically viable oil reserves that have not been put into production: off-shore production from the east and west coasts of the United States, shale formations throughout Eastern Europe and even New York State, on-shore production in the Arctic Circle. Regulatory and cultural barriers have disallowed production in all of these vast zones. Geopolitics has also played a role. Continued debate and conflict over international exploration rights have hampered development in the Black Sea and the South China Sea, both of which were being mapped for exploration as far back at the 1970's.
When prices sat at over $100 a barrel, there was already pressure to ease these restrictions. President Obama opened the possibility of drilling off of the east coast of Florida; Shell infamously attempted to drill in the waters north of Alaska. New York State faced enormous pressure to allow fracking in its shale region just north of the thriving Pennsylvania fields.
Why Does All Of This Matter?
With abundant current supplies, new sources of "old oil" ready to come on stream, and latent "new oil" reserves ready to be brought into production at prices as low at as $35 a barrel, it is essential to understand that we could be back in an extended era of normal oil prices. There are vast implications to the argument that, absent a supply shock, oil prices could continue to fluctuate between $20 and $40 a barrel as they have throughout all but a few of the last 70 years.
Internationally, oil dependent countries like Nigeria have experienced strong economic growth over the last decade based on the anomalously high crude prices. But with a national budget that is 70 percent funded by oil revenue, how does Nigeria, typical of its oil-dependent peers, maintain economic and political stability in the face of the sustained 75 percent decline in prices? We need to at least begin to plan for the kind of economic and political dislocation that may come to countries in which crude oil exports and revenues make up a high percentage of GDP and national budgets. Identifying these countries is easy: just look at their rate of decline in their foreign reserves. Managing the political and economic risks to come requires planning now.
In the United States and Europe, the picture is more complex. There is the benefit of low prices to consumers: For a typical American driving 15,000 miles a year in a car that averages 30 miles per gallon, a fall gas prices from $4 a gallon to $2 a gallon represents $1,000 a year in savings -- the equivalent of a substantial tax cut. Those savings should percolate through the economy in the form of added spending over the course of this year. To a lesser extent, given less driving per capita, the same should hold true in Europe.
However, the US will face a countervailing impact, as oil exploration and development investments are cut. Many oil companies are facing severe financial distress in the face of $30 oil. As with the oil exporting countries, a careful look needs to be given to which US oil producers can survive with normalized prices in the $20-$40 range and which banks are most exposed to those producers. We are already seeing the negative effects of the lower prices in the budgets of oil producing states like Alaska and in the recent bankruptcies of the most vulnerable of the oil exploration and production companies. National policy needs to manage the duality of falling business spending in the oil and gas producing sectors and regions, and the equivalent of a broad-based tax cut stimulating consumer demand nationwide.
Perhaps the biggest long-term question in a world of $20-$40 a barrel oil is what happens to the fast growing renewables industry? In a world in which gas is $2 a gallon, will electric cars remain as attractive? With home heating oil prices down equally drastically, will the switch to electric heat powered by solar happening throughout the northern United States continue? Will covering prairies with solar panels and ridgelines with wind turbines continue to make sense if clean natural gas (found in abundance in the same shale formations) is available at historically low prices?
Predicting the future price of anything, let alone crude oil, is risky business. Markets have a way of surprising. However, given history and reasonable forward looking supply expectations, our national, corporate and personal planning should at the very least make contingencies for the possibility that the price of oil will remain between $20 and $40 a barrel for the foreseeable future.